Why in CFAI MBS examples are the OAS’ always greater than the Z-Spreads? I would have thought that the MBS, because of its prepayment option (unfavorable to the investor) would be cheaper than a straight bond? Here is a simplified example: Assume the yield curve is flat at 10%- So the Z-spread equals the nominal spread. A straight 2 year bond with \$100 (10%) coupon payments is trading for \$1000. Coupons payable annually. The Z-Spread would equal: 1000 = 100/ (1+Z)^1 + 100/ (1+Z)^2 + 1000/ (1+Z)^2 Z= 10% or 1000bp I would think the MBS would have a lower price than the straight bond as it can be prepaid at any time by the holder. (But this may be where I’m wrong) So let’s say the price of the MBS is \$966.2 966.2 = 100/ (1+OAS)^1 + 100/ (1+OAS)^2 + 1000/(1+OAS)^2 The OAS value would equal 12% or 1200bp Then the value of the option would equal Z-Spread - OAS = -200bp But the CFAI always shows the option cost on MBS as positive. The only reason I can think of is that the CFAI text is comparing a MBS with a call option, to a MBS security without a call option. Can you even have a call option on a MBS? Any help or thoughts would be most appreciated.

This doesn’t sound right. OAS for MBS is the spread that you add to every nodes in a Monte Carlo simulated binomial tree. (Hence, the OAS for MBS is the average spread that you add to treasury spot rates.) The way you evaluate a MBS using a single interest rate path doesn’t seem right to me.

You may be correct: I was thinking that a monte carlo model is used to determine the price of the bond then the OAS is just calculated from that price. So that you can compare it to the treasury curve. So under your reasoning does the option add value to the MBS or reduce value?

OAS>Z because option is held by the seller of the MBS. i.e. the homeowners have a right to prepay, so buyers of the MBS have to be compensated for selling this option, this occurs via a higher spread.

Page 462 CFAI text on alternative investments shows the OAS< Z-Spread. Why?